Chapter 10: Commercial Property Insurance

Question 1

mercantile risks

Answer 1

Different types of business operations, and their different types of exposure,

Question 2

Considerations for Commercial

Answer 2

1) Building.
2) Stock.
3) Equipment.

Question 3

Building

Answer 3

1. Fixed structures pertaining to the building and located on the premises.”
   “Premises” are defined as the entire area within the property lines and areas under adjoining sidewalks and driveways. It includes erected pole signs, yard lights, and perimeter fencing constructed on the premises. Each structure must be noted on the declarations to be covered by the policy.

“2. Additions and extensions communicating and in contact with the building.

3. Permanent fittings and fixtures attached to and forming part of the building(s).”

The value of plumbing, heating, air conditioning, lighting fixtures, wall-to-wall carpeting, and other permanently installed equipment is included in this amount.

“4. Materials, equipment and supplies on the premises for the maintenance of, and the normal repairs and minor alterations of the building or for building services.”

Any material on site for new construction or major renovation would not be covered.

“5. Growing trees, plants, shrubs or flowers inside the building use for decorative purposes when the insured is the owner of the building.”

This applies to the owner of the building, because a tenant would not have an insurable interest in the building.

Question 4

Stock”

Answer 4

“1. Merchandise of every description usual to the insured’s business.”

The type of business in which the insured is engaged will usually be indicated on the declarations page. When a client purchases stock insurance, they receive coverage for all merchandise or items sold that are usual to that business. For example, If the insured’s business was described as a bookstore, but they submit a claim for bicycles sold by the shop, the insurer would have grounds to deny such a claim.

The rate and premium charged are based largely on the nature of the stock, because there is a wide variation in susceptibility to loss from one type of stock to another. For example, high-end bicycles have a higher potential for loss and would warrant a higher premium.

“2. Packing, wrapping and advertising materials.”

This includes all material used to distribute any of the merchandise sold. It includes advertising and promotional material, such as flyers and catalogues.

“3. Similar property belonging to others which the insured is under obligation to keep insured or for which the insured is obligated.”

Note that, under this definition, the property lost or damaged must be similar to that insured by the policy. This means that goods held on consignment must be similar to those stated on the declarations page.

The insured must have had an obligation to keep the property insured. The normal practice is to have a written agreement in place outlining the obligations of both parties.

Additionally, the insured must have been legally obligated either as a bailee or based on the standard of ordinary care. From an underwriting point of view, it is important to know the nature of all the stock in a building and how it relates to the insured’s business.

Question 5

Equipment

Answer 5

“Equipment” is defined as:

“1. Generally all contents usual to the Insured’s business, including furniture, furnishings, fittings, fixtures, machinery, tools, utensils and appliances other than ‘building and stock’.”

Equipment can include office furniture, fittings, and display cases, as well as machinery ranging from air compressors to forklifts.

“2. Similar property belonging to others which the insured is under obligation to keep insured or for which they are legally liable.”

You might remember this clause from the definition of “stock,” and the intention is identical. Many operations lease or rent equipment, such as photocopiers, computers, office furniture, and forklifts, so this definition includes those items. Brokers need to know not only what is owned, but also any lease agreements related to the business.

“3. Tenants improvements, which are defined as building improvements, alterations and betterments made at the expense of the Insured to a ‘building’ occupied by the insured and which are not otherwise insured provided the Insured is not the owner of the building.”

Renting space in multi-use buildings — such as malls or high-rise buildings — is very cost-effective for many insureds. The space is often unfinished and the tenant/insured finishes the space to their own specifications. These tenant improvements and betterments are normally left in the building when they leave. Because the tenant has no interest in the building, but they paid for these improvements and betterments, these tenant improvements must be insured as equipment on the tenant’s policy.

If the insured purchases the use interest on tenant improvements made by the previous tenant, this form applies as though the tenant improvements had been made at the expense of the insured.

Once the broker has identified these components and given the appropriate values by the insured, the broker can then analyze the risk exposure each component presents. However, there may be challenges to ensuring adequate limits are met. To ensure adequacy of limit we apply the co-insurance clause with a co-insurance factor dependent on the type of building, operation and products (discussed in Section 10.3.5). Once all these parts are determined, we can then look at the type of policy required to meet the insured’s requirements and expectations.

Question 6

Determining Insurance Values

Answer 6

(ACV) and replacement cost (RC). The traditional meaning of ACV is the cost to repair or replace lost or damaged property, less the application of any depreciation. In other words, it’s today’s price, less depreciation. RC represents the costs to repair, replace, or rebuild the lost or damaged property, without deduction for depreciation. Insuring a building on an RC basis usually requires a proper appraisal.

Stock is insured on ACV basis, whereas equipment can be insured on either. Again, the onus is on the insured to provide the proper data to ensure adequate limits in case of loss. These limits can be determined from invoices and inventory figures, and they are probably easier to determine than building values. (This is particularly true for older buildings, whose valuations can be more subjective.)

Question 7

Co-insurance Clause

Answer 7

DID / SHOULD * LOSS = PAYOUT

Essentially buying insurance less than the amount that would cover your property and willing to incur a loss for a smaller premium

Below is an example of a co-insurance clause:

“This clause applies separately to each item for which a co-insurance percentage is specified on the Declarations page and only where the total loss exceeds the lesser of 2% of the applicable amount of insurance or $5000.

The insured shall maintain insurance concurrent with this form on the property insured to the extent of at least the co-insurance percentage specified on the Declarations page of the Actual Cash Value (ACV) thereof and failing to do so, shall only be entitled to recover that portion of loss that the amount of insurance in force at the time of loss bears to the amount of insurance required to be maintained by this clause.”

In commercial property, the insurer will normally require the insured to purchase an amount of insurance which, as a minimum, is equivalent to a predetermined percentage of the property’s value (usually 80% or 90%). When the amount of insurance purchased is less than this amount, the insured will be required to share in any future loss (that is, pay themselves). The formula used to determine the amount of the loss to be borne by the insured is included in the policy’s co-insurance clause.

The co-insurance clause exists because many people will deliberately under-insure to reduce the amount of premium they pay. Others may be careless in their estimate of current values and end up woefully under-insured. In other cases, they are expecting to suffer only a partial loss, so they base their purchasing decisions on that expectation. However, in the event of a total loss, insureds often expect full payment for partial losses — even if they failed to pay sufficient premium to cover the whole property.

The co-insurance clause prevents this from happening. In the event of a total loss, the payout to the insured is limited by the policy limit purchased. This means that, if the insured is under-insured, they would suffer a financial loss to the amount they are under-insured for. In the event of a partial loss, they would also be penalized by only receiving payment based on the formula which determines that shortfall.

Confused? Let’s look at an example.

John insures his $1,000,000 commercial property for $10,000. If his property is totally destroyed, should he expect his insurance to pay for $1,000,000 or $10,000?

It makes little sense to pay 100% of all losses when the amount of insurance purchased is significantly less than the total value of the property.

Sandy owns the unit next to John. Her commercial property is valued at and insured for $1,000,000. If she suffers the same loss as John, should she expect her policy to help pay for John’s loss?

It is unfair to ask other insureds who purchase the required amount of insurance to subsidize those who do not.

Question 8

The Formula - Coinsurance

Answer 8

Did ÷ Should × Amount of the Loss = Settlement

Example:

150k / 240k (Should in this case is the % required by Co Insurance. Sometimes 80%, 90% of the property) * loss = Settlement

Question 9

Co-Insurance Deductible - Deductible Clause

Answer 9

When a loss is subject to a co-insurance penalty, the amount of the loss is calculated first, followed by the amount of the deductible. In the example above, the insurer would first calculate the loss of $18,750 and then apply the appropriate deductible. If that deductible was $1,000, the net payment to Antonia would be $17,750.

Question 10

Risk Analysis

Answer 10

Construction.

• Masonry and fire-resistive buildings that use modern building materials make a risk more attractive than a frame structure.
• The age of the building impacts the viability of its mechanical components and has a direct relation on whether a building meets modern building and fire codes.

2)Occupancy.

• The occupancy of the building by both the insured and others will affect the fire rate.
• In multi-occupancy buildings, the occupant with the highest exposure will affect the rate of all the building occupants.
• The type of contents (either raw or finished products) and the manufacturing process to produce those items directly affects the rate. For example, an insurance broker’s office would generate a rate well below a plastic parts manufacturer with highly flammable stock.

3)Protection.

•The availability and type of fire protection has a direct effect on the rate. Public protection includes the distance from fire hydrants (which determines water supply) and the number of local professional full-time fire stations (which determines response time). Private protection includes the internal activities of the building to prevent or reduce loss (such as sprinkler systems, fire extinguishers, and properly installed and monitored central station fire detection systems). These protections will reduce the rate for a risk.

4)Location.

•The physical location has a direct effect on the rate. The distance from other buildings, the construction of neighbouring buildings, and the character of the neighbourhood all impact the rate.

5)Claims History.

•The insurer will review the claims history of the insured and of similar businesses over a period of time (for example, the previous five years) to determine both the frequency and average severity of losses. Even though a loss is an unforeseen event in the future, the past history of both the insured and the industry is a pretty good indication of the likelihood of loss.

Question 11

Policy Forms

Answer 11

Named Perils

Broad Form

Question 12

Named Perils Form (IBC 4036)

Answer 12

The Named Perils Form (IBC 4036) is a very basic form that provides limited coverage for a risk. It can be used for difficult risks or for risks that require only limited coverages.

The Named Perils Form provides coverage for:

• Fire.
• Lightning, including loss or damage to electrical devices.
• Explosion (limited).
• Impact by aircraft, spacecraft, or land vehicles.
• Riot, vandalism, or malicious acts.
• Smoke due to a sudden, unusual, and faulty operation of any stationary furnace.
• Leakage from fire protective equipment.
• Windstorm or hail.

Question 13

Broad Form (IBC 4037)

Answer 13

The Broad Form (IBC 4037) insures against all risks of physical loss or damage, subject to policy limits and exclusions. It is comparable to a comprehensive policy in habitational insurance.

Note that there is a Broad Form Homeowner Policy which provides all-risks coverage on the building and named perils on the contents. However, in commercial insurance, a Broad Form is entirely all-risks, so the loss is insured unless a specific exclusion in the policy says it is not. When you hear the term “Broad Form,” it’s important to be clear whether it’s a personal or commercial policy.

Even the term “all-risks” is a misnomer. It would be rare to find an insurance policy which insures against all losses without exception. All policies contain exclusions for both property and perils insured, as well as a number of miscellaneous conditions. Insureds need to be reminded that even the broadest coverage forms have limitations in what they insure.

Earlier in this chapter, we learned the definition of property, what it includes, and what needs to be identified on the declarations page. Now, we’ll examine the specific property and perils that are excluded under the Broad Form.

Examples of excluded property include:

• Sewers, drains, and watermains located beyond the outside bearing walls.
• Street clocks and exterior signs.
• Animals, birds, and fish.
• Money, platinum, cash cards, evidence of debt or title.
• Automobiles, watercraft, aircraft (but not unlicensed automobiles or unlicensed trailers) used on the insured premises while on the insured’s business.
• Property in the custody of sales representatives outside the premises, unless an amount is shown on the declarations page for the sales representative.
• Any pressure vessel having a working pressure greater than 103 kilopascals.
• Any boiler, including its connecting pipe and equipment, containing steam or water under steam pressure.

Examples of excluded perils include:

• Earthquake.
• Flood.
• Seepage and leakage.
• Backup or overflow of water from sewers, sumps, septic tanks, and drains.
• The entrance of rain, sleet, or snow through doors, windows, skylights, or other openings.
• Centrifugal force, mechanical, or electrical breakdown.
• Failure to control temperature or humidity.
• Trade losses.
• Pollution and contamination.

Question 14

Common Clauses

Answer 14

DEBRIS REMOVAL CLAUSE
REINSTATEMENT CLAUSE - Under contract law, the insurer’s financial obligation to the insured is over when the limits of insurance have been fully used to pay claims. However, the unique nature of insurance contracts has resulted in insurers including the reinstatement clause in commercial and other property insurance policies. This clause means that the limits of insurance provided by the policy remain unchanged for the entire policy period, regardless of the number and amounts of claims paid.

SUBROGATION CLAUSE - to not go after those who have an insurable interest in the property

Question 15

Property Away from the Insured Premises Policy

Answer 15

Commercial property insurance coverages apply only at the location noted on the declarations page. For an additional premium, coverage can be purchased and added to the policy to provide for both property in transit (by both the insured’s and others’ vehicles) and property at a temporary location not owned, rented, or controlled by the insured.

Question 16

Glass Coverage Policy

Answer 16

Limited coverage is available under the Broad Form for exterior glass. Exterior or interior glass (such as in a mall) requires additional coverage. Many tenants, whether in a mall or street-facing building, have leases that require them to be responsible for loss to the glass of their unit. The combination of glass, ornamentation, lettering, and artwork is a significant investment for the insured.

Many insurers’ glass coverage policies provide as few as three exclusions:

1) Fire.
2) War.
3) Nuclear energy hazard.

Question 17

Valuable Papers and Records Policy

Answer 17

Valuable papers are defined in IFC 51065 as “written, printed and otherwise inscribed documents and records, including books, maps, films, drawings, abstracts, deeds, mortgages and manuscripts but does not mean money or securities.”

Standard commercial property insurance policy coverages restrict payment for records to their blank value only. But when an insured purchases this coverage, all costs of reproducing lost or damaged documents are covered.

Question 18

Accounts Receivable Policy

Answer 18

Many insureds extend credit to their customers through their business. If those records are destroyed, this policy can offer coverage. The act that destroyed them (that is, the peril) does need to be listed in this policy for it to respond, but the intent of the coverage is to pay the costs of reconstructing accounts receivable records, abnormal expenses incurred in collecting sums due to the insured, and interest charges on loans needed to offset uncollected amounts.

Question 19

Office Equipment Floater

Answer 19

Businesses operate in a variety of forms, from retail to manufacturing — but offices are extremely common. Unlike retail or manufacturing environments, these office businesses (such as accountants, lawyers, and insurance brokers) do not contain any stock under the strict definition, but they do contain equipment. This policy provides all-risks coverage on all the office equipment, and generally includes accounts receivable, valuable papers, and extra expense.

Question 20

Electronic Data Processing Policy

Answer 20

Very few businesses can operate without automation. From inventory control in warehouses to sales checkout in retail stores, all businesses rely on automated systems to some degree. Even operations in insurance brokerages, from application to record storage, are digitized. This means a computer failure can result in a total shutdown of a business operation.

Coverage under the standard commercial property forms is often not sufficient to fully address the unique losses that insureds using automated systems are exposed to. The Broad Form typically excludes losses caused by artificially generated electrical currents (for example, a power surge).

The loss of data is excluded under the Broad Form Policy, so insureds need to purchase coverage for the computer system in their office or business through an electronic data processing policy. There is no standard policy for this purpose, so brokers must be aware that the following coverages need to be on the form for their client:

• Loss to data processing systems, including equipment and component parts.
• Active data processing media, including programs.
• Extra expense.

Clients will need coverage for the hardware, the software, and the expenses to rent systems from others until the covered property is back online. An all-risks policy will provide coverage for water losses, including leakage, seepage, freezing, and flood, as well as mechanical breakdown.

There are exclusions on all policies, so be aware of the limitations on each form.

Question 21

Crime Insurance Policy

Answer 21

Commercial property insurance typically provides coverage for riots, vandalism, and malicious acts. The Broad Form policy provides coverage for theft of stock and equipment. However, even the broadest policies exclude money, securities, jewellery, furs, and other valuable property when the loss is due to a criminal act. As always, brokers need to be deeply knowledgeable about their insured’s business in case there are exposures requiring additional coverages.

Burglary insurance is required in any business where the stock or equipment has high value or by its nature is very attractive to thieves. Burglary insurance will only pay when there are signs of forced entry to or from the insured property. The insured can purchase either mercantile stock burglary insurance or safe burglary insurance.

Robbery insurance is purchased where there is potential loss to money, securities, and other valuable property. Robbery insurance will pay when there is the threat of force against the person having control of the property (for example, a thief threatening a staff member with harm to turn over cash from the register). Robbery insurance applies to both inside and outside the premises.

Theft is the broadest form of crime, involving property taken without the owner’s consent. An insured who purchases theft coverage does not have to purchase burglary or robbery insurance, but the premium will reflect the extent of this coverage. Theft coverage includes options such as: Broad Form (covering stock and equipment); Money and Securities Broad Form; Employee Theft and Fidelity coverages; and the Comprehensive Dishonesty, Disappearance, and Destruction Policy (also known as the 3-D Policy).

The 3-D Policy provides a comprehensive package of crime insurance coverage under a single policy form. It includes five insuring agreements, and there are 48 approved endorsements to this policy which allow the broker to amend the coverage to a particular risk.

Question 22

Equipment (Boiler and Machinery) Breakdown Policy

Answer 22

The Commercial Property Broad Form excludes “loss or damage to buildings resulting from explosion of the following whether owned, operated or controlled by the insured: Boilers and pressure vessels operating at more than 15 psi.”

Many large buildings heat with hot water and require large boilers operating at pressure to provide the heat. Many also have large electrical systems, electric motors, compressors and pumps, and air conditioning systems. Brokers will conduct surveys of the building to identify any building systems and equipment that require this specific coverage.

This is specialized insurance, so the insurance company will inspect the objects being insured. The inspection can be done at any time. If the inspector deems the equipment as unfit or dangerous, they can tag the equipment and suspend the coverage immediately, without notice to the mortgagee.

Question 23

Contractor’s Insurance

Answer 23

Commercial property insurance does not cover buildings during construction. A separate Builders Risk Form is required to provide coverage for this exposure. This policy can be purchased by either the contractor or the future owner of the building.

This policy insures the value of all materials owned by the insured and others entering into and forming part of the completed project. It excludes the contractor’s tools and equipment (which require its own coverage under a contractor’s equipment floater) and the cost of making good faulty workmanship. The policy is meant to cover only the period when the building is under construction; this means it will likely cease before the building becomes occupied. It can also cease if the project has been left in an unaltered state or there has been no construction activity for more than 30 consecutive days.

The limit purchased is based on the completed value.

Question 24

SPECIFIC POLICY FORMS

Answer 24

Business Interruption Insurance

Question 25

Business Interruption Insurance

Answer 25

Businesses run on their own will, planning, and funding — but they may experience a stop to their operations that they did not entirely intend. When external factors pressure a business to cease operations, this can be considered a business interruption. However, business interruptions are not always straightforward, so let’s look into this policy.

Commercial property insurance policies typically insure only the direct damage caused to the building, stock, and equipment. When there is a significant loss to property, one of two things can happen:

1) The business may be forced to close for a lengthy period. A closure lasting a few days may reduce the company’s business, while a lengthy closure (for example, weeks or months) can be disastrous (for example, the months-long closures during the 2020 COVID-19 pandemic).
2) The business is able to resume partial operations only at the insured or other locations.

Business interruptions can come from many different sources other than damage to property. There can be a failure or breakdown of public utilities, transportation accidents (for example, the 1979 Mississauga train derailment), damage to neighbouring premises, loss caused by property damage of a major supplier, or actions of a regulatory authority.

During this period, when income is stopped, insureds have a few options to get their business back up and operating. They can dip into their own capital reserves (if they have any) or they can take out a bank loan (which they have to pay back from future earnings). Unfortunately, most businesses that experience a major property loss fail to reopen after three months, because they are unable to pay for continuing expenses during the interruption. Transferring that risk to an insurance company can help ensure the survival of that business.

Business interruption serves the following functions:

• It is a contract of indemnity, designed to restore the lost income to a level it would have been prior to the loss. It pays the business’s ongoing expenses (including salaries for key management personnel, taxes, and mortgage payments) and expenses which continue after a loss, as well as lost profits.
• It insures the same perils as the property policy.
• Its coverage is not limited to the policy period. Business interruption coverage starts on the day of the loss to the property and can continue for a specified period (usually 12 months). It will continue even if the property policy expires during that period.
• It will pay expenses when they are required to reduce the amount of the loss.

Question 26

Business Interruption - Gross Earnings Form:

Answer 26

The indemnity period commences at the time of loss and ceases upon reinstatement of the lost or damaged property. By ceasing payment at this time, the Gross Earnings Form assumes that the insured is returning to the competitive position they were immediately prior to the loss.

Question 27

Business Interruption - Profits Form

Answer 27

The indemnity period commences at the time of loss and continues until the income is restored to the level that would have been earned if the loss had not occurred, subject to the indemnity period selected at inception. The assumption here is that, although the doors of the business are open, the business has not been restored to its former competitive position. It will take time before profits are restored to the pre-loss level and to win back customers after a prolonged interruption. The Profits Form has a higher premium due to this longer coverage period.

Question 28

Business Interruption - Extra expense insurance endorsement:

Answer 28

This is not a true business interruption insurance form because it does not insure loss of income. Instead, this form insures the necessary extra expenses or costs incurred by insureds in continuing normal business operations after a loss. Businesses purchasing this coverage include those which could (or need) to be back in business after a short interruption, such as insurance brokers, travel agents, doctors, and banks. In these situations, the business’s physical location is important, but not vital in the short term — so lost income due to location loss is not of major concern for these types of businesses.

Extra expense coverage is limited to those expenses that are over and above those which normally would have been incurred by the insured had the loss not occurred. These extra costs include:

• Renting temporary premises.
• Renting temporary equipment.
• Paying overtime salaries.

The insured would buy a single limit, and payment is spread out over a defined period.

Question 29

SURETY BONDS

Answer 29

1. There are three parties to a contract. (principal, obligee, surety)
2. No losses are expected.
3. The principal is liable to the surety.
4. There is a bond premium, which is effectively a service fee. This is a fee charged for pre-qualification and company expenses to underwrite the risk.
5. There is a bond limit, or penalty, which the surety will pay to the obligee if the principal defaults. The penalty remains unchanged through the contract period.
6. A surety is of indeterminate length and non-cancellable.
7. It is a written contract and executed under seal of the surety and principal.

Question 30

Construction bonds:

Answer 30

The owners of a project face various risks in the management of the project. Successful bidders who fail to enter into the project can stall the project and cost time and money. Contractors who fail to complete the project on time and on budget can jeopardize the project. Contractors who fail to pay their sub-trades and suppliers can result in protracted litigation. In response to these challenges, contractors provide bid bonds, performance bonds, labour and material payment bonds, and maintenance bonds to cover warranty of the completed work.

Question 31

Fiduciary bonds:

Answer 31

These are required for each insurance brokerage under the RIB Act. Fiduciary bonds are required when you have people in a position of trust who are handling the funds of others. These bonds also apply to persons appointed by the courts to act as estate administrators, guardians, or trustees.

Question 32

Customs and excise bonds:

Answer 32

These are required for custom-bonded warehouses which guarantee the collection of duty and taxes on goods brought into the country.

Question 33

License and permit bonds:

Answer 33

These are required by all levels of government for businesses operating under their respective jurisdictions. Businesses operating publicly must post the required bonds to ensure they meet the statutes, regulations, or ordinances under which they operate. This is meant to protect the general welfare of the public.

Question 34

PACKAGE POLICIES

Answer 34

Package policy coverages are not standardized, but they generally include the following:

• Property insurance.
• Business interruption insurance.
• Liability insurance.
• Crime insurance.

Premiums are based on what the insurer deems to be the quality of the average exposure, and credits are given for select or superior risks. Though there is a common form for each program, the credits earned by the individual risk quality make each package policy unique to the insured.

The advantage of package policies is the simplicity of the application form. Premiums are easily determined, coverage is usually more than adequate for most risks, and the broad coverages provided eliminate many of the claims problems common to the more limited forms.

The disadvantage of this approach is that one size does not fit all. When brokers conduct their surveys, they must identify areas where the package policy’s preset limits may have a serious effect on the coverage limits required by the insured. Because package policies lack standardization, it is difficult to make comparisons. Over-reliance on the package policy may leave some insureds seriously under-insured. Ultimately, an individually tailored commercial policy may be a more effective way to deal with your clients’ insurance needs.